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Pivot Point Trading
You are going to love this lesson. Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.
The reason pivot points are so popular is that they are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).
Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.
Before I go into how you calculate pivot points, I just want to point out that I have put an online calculator and a really neat desktop version that you can download for free HERE
If you would rather work the pivot points out by yourself, the formula I use is below:
Resistance 3 = High + 2*(Pivot - Low)
As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.
If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.
The three most important pivot points are R1, S1 and the actual pivot point.
The general idea behind trading pivot points are to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.
A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.
Unfortunately life is not that simple and we have to deal with each trading day the best way we can. I have picked a day at random from last week and what follows are some ideas on how you could have traded that day using pivot points.
This gave us:
Resistance 3 = 1.2377
Have a look at the 5 minute chart below
The green line is the pivot point. The blue lines are resistance levels R1,R2 and R3. The red lines are support levels S1,S2 and S3.
There are loads of ways to trade this day using pivot points but I shall walk you through a few of them and discuss why some are good in certain situations and why some are bad.
The Breakout Trade
The Pullback Trade
Breakout of Resistance
We haven't even got into patterns around pivot levels or failures but that is not the point of this lesson. I just want to introduce another possible way for you to trade.
Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our disclaimer.
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